Wednesday, May 30, 2007


Petrobras (PBR), the national oil company of Brazil, is the most undervalued public major oil company (outside of Russia) on the basis of proven reserves of oil and natural gas. Petrobras is unique in the oil major universe in that it not only has a low valuation on the basis of proven reserves, but also has strong prospects for increasing oil and gas reserves and production. Further, Petrobras is the first oil major to move significantly into ethanol distribution and production. These factors are discussed in more detail below.

Valuation Comparison Chart:
Ticker: Company Name
Proven Reserves
Proven Reserve to Production (R/P)(years)
Probable & Possible Reserves
Enterprise Value (US dollars)
Standardized Measure (from 10-K 2005 -- PBR has not published its 2006 10-k as of 6/07)
Standardized Measure (proved)/Enterprise Value

PBR: Petrobras (Brazil) [E&P: 90% 05 income];
11.775 BBoE (17% gas, 83% oil);
15.4 years;
$109Bn (YE 05 prices of oil and gas -- 06 values not available at 5/07)
Standardized Measure/Enterprise Value: 1.01x

PTR: PetroChina[E&P: 100% 05 income, Marketing: minimal inc Refining: loss]
19.56 BBoE (41% gas, 59% oil)
18.4 years
$175.2Bn (YE Chinese Prices)
Standardized Measure/Enterprise Value: 0.88x

China Ntnl Offshr Oil Co [E&P 100% 05 Income]
2.36 BBoE (68% oil)
5.6 years
$25.2Bn (YE Chinese Prices)
Standardized Measure/Enterprise Value: 0.73x

Sinopec (China)[E&P: 70% 05 income, Marketing 15%, Chem: Refin: 15% loss]
3.362 BBoE (14.7% gas, 85.3% oil)
10.6 years
$44.1Bn (YE Chinese Prices)
Standardized Measure/Enterprise Value: 0.54x

[65% 05 income E&P, 22% ref & marketing]
13.37 BBoE (42% gas, 58% oil and NGL’s) reserves exclude oil sands
9.0 years
$99.2Bn (YE prices of oil and gas) (55% of standardized measure in US/Can/EU)
Standardized Measure/Enterprise Value: 0.25x

(Note: the figures above are dated as the market capitalization values are from mid 2006 and the reserve valuations are from year end 2005).

Petrobras operates in three main divisions: 1) Upstream: PBR develops oil and natural gas reserves mainly off the coast of Brazil, 2) Downstream: PBR refines and markets petroleum products mainly in Brazil, and 3) Ethanol: the Company distributes and exports ethanol.

PBR Upstream Operations Analysis:

Petrobras derived approximately 90% of its net income from its upstream operations (Exploration and Production) according to its latest annual report (05). PBR produced an average of 1.77mbpd of oil -- out of a world average production of approximately 86 mpd of oil -- and expects to produce 1.919 mbpd of oil in 2007, as new projects come on line offsetting existing declines in existing oil fields.

Petrobras has good prospects for increasing oil and natural gas reserves on offshore Brazil as the company can explore more fully the Campos Basin, and then move down to the Santos Basin, to the south, of a similar geographic size to Campos (although the geology obviously differs). The Campos Basin is 100,000 square miles but has had significantly less exploration than the Gulf of Mexico, which produces a similar quantity of oil -- GoM produced approximately 1.8 mbpd of oil in 2005 while Campos produced approximately 1.7 mbpd of oil in 2005 -- and further exploration is promising. There is high interest from majors in all blocks offered in Campos for the purposes of oil and gas exploration.

Petrobras has a very large amount of territory to explore off the coast of Brazil -- as a comparison, the country is approximately the same size as the United States ex Alaska. Although Petrobras does not explicitly state that it hasn't fully explored the Amazon basin, the author has not seen anything that shows that PBR has spent a large amount of funds exploring this area. Note that most large offshore oil deposits occur in basins in a near proximity to rivers -- Campos and Santos basins notwithstanding, as these are not close to rivers (note that this last statement concerning is this author's opinion only, and the author is not a petroleum geologist).

Historically, the government of Brazil has awared Petrobras the vast majority of territory claims on offshore Brazil, and this is expected to continue in the intermediate term -- all blocks are opened by the Brazilian government to bids to cooperate with Petrobras and only one block is independently produced by a firm other than PBR -- although this could change as the Brazilian government has moved towards opening up the oil sector. Note however that most Brazilian domestic oil firms besides PBR do not currently have the capital to compete with PBR -- Petrobras estimates that in 2005 it developed more than 98% of Brazil's oil and gas reserves, according to its Annual Report filed with the SEC.

Oil Field Analysis:

Over 90% of Petrobras' reserves are located in the Campos Basin, 50 miles off the coast of Brazil, in deepwater (over 1000 meters). PBR's major fields in the Campos Basin are reported as follows:

Campos Basin:
Field Name: Estimated Size (oil barrels): 2006 Production Notes:
1a. Marilin 1.229 Billion 414,200 bpd Largest Field to date, peaked in 2002 at 586,312 barrels per day
1b. East Marlin see Marlin above 160,000 bpd 09 (0 now) Extension of the Marlin Field
1c. South Marlin see Marlin above 430,186 bpd 11 (185,740 now)
2a Barracuda 1.229 Billion 169,903 bpd Connects with Caratinga listed below
2b Caratinga connects w/ Barracuda above 141,198 bpd Both Caratinga and Barracuda have not peaked
3a. Albacorra N/A 114,878 bpd Peaked in 1998 at 199,800 bpd
3b. East Albacorra N/A 61,000 bpd Under development
4. Espadarte N/A 24,500 bpd Under development
5. Roncador N/A 84,000 bpd Under development

Petrobras' largest discovered field to date has been the Marlin field, which contains an estimated 1.7 billion barrels of remaining oil. This field has been in decline since 2002, from 586,312 bpd of production to 414,200 bpd currently. In the immediate area of Marlin are the East Marlin and South Marlin fields, which are forecasted to combine to produce a combined 590,200 barrels of oil in 2008. These two fields are forecasted to more than offset the projected declines from the main Marlin field in the near term.

Santos Basin:
Field Name: Estimated Size (oil barrels): 2006 Production Notes
1. Jubarte 600MBoe 180,000 (2011) Mainly heavy oil
2. Tupi 1.7 BBoe to 10 BBoe (initial) No Production time frame as of 6/2007

The Santos Basin has only been relatively lightly explored to date (mid 2007), although the basin lies in close proximity to Sao Paolo and therefore is a very good prospect to be developed economically. The largest potential discovery was made in October 2006 when PBR's partner UK's BP Group PLC discovered light oil in the Tupi field, initially estimated at between 1.7 to 10 BBoE, however, PBR later reported in 2.07 that it is too early to estimate the economically recoverable reserves of the Tupi discovery.

Notes on Petrobras' SEC vs SPE Reserves:

Petrobras' SPE stated oil reserves stand around 12Bn barrels of oil -- in comparison with its SEC stated reserves of slightly under 10 billion barrels. The significance of this fact is that SPE allows for the reporting of more "probable" oil reserves -- oil reserves that are commercially produceable with less than 90% certainty -- compared to SEC oil reserves guidelines, which mandate only proven (90% certainty) reserves are reported. Note that 12 billion barrels of oil are very large numbers -- in comparison, KMG -- the national oil company of Kazakhstan, reports approximately 8 billion barrels of oil in proven reserves according to the Baker Institute for Energy Studies (Kazakhstan is one of the hottest areas of the world for investment into the oil sector).

PBR Ethanol Production:

Petrobras is the world's largest distributor and exporter of ethanol fuel, exporting approximately 60% of global exports of ethanol. PBR has since 1980 purchased ethanol from Brazilian farms and distributed it for Brazil's own use and for export. Ethanol is at mid-2007 a relatively low percentage of overall net income, at less than 5% ($R189M/$R4.2Bn) of total 1Q 07 net consolidated income. Petrobras intends to expand its exports of ethanol from 850m litres in 2007 to 3.5bn litres a year by 2011 (367% total growth). Petrobras forecasts that ethanol will be Brazil's top commodity export in 2017, overtaking soya -- estimates are that ethanol will contribute $US24Bn to the Brazilian economy in 2015 (up from $US6Bn currently).

Petrobras is entering the production of ethanol by purchasing sugar fields -- integrating its distribution and marketing functions in the ethanol industry -- which may improve margins. Overall, Petrobras is forecasted to significantly improve profits going forward from ethanol fuel, although E&P will remian the largest segment for Petrobras in terms of profitability over the medium term.

Risk: Is Petrobras at Risk Due to Its Exposure to Deepwater Oil Production?

The largest risk to Petrobras is its deepwater oil and gas exposure: deepwater production is more expensive than onshore oil production, and deepwater production tends to undergo faster peak times and stronger declines. These factors are partially mitigated by Petrobras positive prospects, and overall undervaluation based on existing reserves, with faster depletion rates -- the standardized measure takes into account development costs.

No comments: